Abstract:

This paper analyzes the impact of agglomeration externalities on hourly earnings using longitudinal worker micro-level data from the Annual Survey of Hours and Earnings over the period 2002- 2006. We find that the effect of agglomeration externalities on wages is sensitive to the estimator used. Controlling for nonzero correlation between workers’ unobservable skills and other covariates halves the size of the wage elasticity of agglomeration externalities. On the contrary, accounting for firms’ unobservable heterogeneity has only a weak contribution to the explanation of wage differentials. Another interesting result is that correcting for reverse causality between productivity and agglomeration does not appear to have a substantial impact on the magnitude of the parameter estimates. Our best estimate for the effect of labour market density (market potential) is 0.8% (5.8%). This means that doubling labour market’s employment density can raise hourly earnings by nearly 1%, while halving the distances to other markets produces an increase of hourly wages of nearly 3%. The last piece of evidence refers to the spatial attenuation of agglomeration externalities. We estimate that a 100,000 increase in the number of jobs within 5 kilometres raises hourly wages by approximately 1.19%; the effect falls sharply thereafter.

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